The 4th Quarter Is the Best Time for Machine Shops to Acquire New Equipment
Acquiring new equipment can be a challenging proposition. One important consideration is timing the acquisition to maximize the tax benefits. Some of these benefits may require action before the end of a calendar year. Financing options such as a tax lease give shops a variety of strategies for making crucial decisions late in the game.
In the fourth quarter, many machine shops consider the profits and losses of the current year and start planning for the next year, including whether they need to acquire new equipment to stay competitive.
The benefits of new equipment come from using it rather than owning it. But among the factors that need to be considered when acquiring new equipment is how to pay for it. This is where equipment financing comes in as a viable solution that can help machine shops:
- optimize cash flow;
- manage risk;
- preserve lines of credit; and,
- potentially realize substantial tax benefits.
For many shops, asset depreciation is an important part of financial management. All equipment offers depreciation benefits, but it requires some consideration to determine whether a shop can effectively use all of that depreciation.
For equipment-intensive businesses, this is especially true. Full taxpayers that need the sheltering effect of equipment depreciation will typically benefit from tax ownership of equipment. This can be accomplished with a loan, installment payment agreement and some leases. All of these options allow the user to deduct depreciation and interest charges from taxable income.
Machine shops with a more complex tax situation may want to consider a tax lease. Tax leases effectively trade tax depreciation for lower payments. Plus, tax leases allow the entire lease payment to be deducted as an operating expense. Following is a list of factors to consider when evaluating equipment acquisition options.
- Alternative Minimum Tax (AMT) – Machine shops near to or already paying Alternative Minimum Taxes should be aware of the implications of purchasing assets. These businesses may not be able to effectively use all of the tax benefits associated with accelerated equipment depreciation. Consequently, they can experience an increase in the after-tax cost of acquiring an asset.
In contrast, a tax lease can minimize the creation of additional tax depreciation. The lessor records the equipment ownership and resulting depreciation, and because equipment leasing companies are able to more efficiently utilize the tax benefits associated with depreciation, the lessee can enjoy the savings in the form of lower monthly payments.
- Net Operating Losses / tax credits - A lease agreement may also be advantageous for corporations with expiring Net Operating Loss (NOL) carryforwards or other similar tax credits. Depreciation deductions on purchased equipment reduce taxable income, sometimes preventing a machine shop from fully using its available tax credits. Leasing allows shops to maximize the use of the credits to lower the tax liability. In this manner, tax benefits are passed on to the customer in the form of lower payments.
- Mid-quarter convention - The mid-quarter convention states that if a company acquires more than 40% of its capital assets during the fourth quarter, it must recalculate its depreciation expense using the mid-quarter convention tables. Most businesses attempt to avoid the mid-quarter convention by closely managing the amount of assets they purchase (and place in service) during the fourth quarter.
Leasing, however, allows shops the freedom to acquire the equipment they need, when it is needed. By assigning the ownership role to the lessor, businesses avoid the fourth-quarter asset acquisition restrictions; yet still receive the full MACRS tax advantage in the form of lower payments – because the lessor records the ownership of the asset(s). Leasing can be a helpful option when project delays or unexpected equipment replacement needs arise in the fourth quarter.
The IRS Code Section 179 is an incentive created by the U.S. government to encourage businesses to invest in capital equipment. It covers accelerated write-offs for capital purchases and is particularly beneficial to smaller machine shops with limited budgets.
In 2015, businesses purchasing $200,000 or less in capital equipment can deduct up to $25,000 of that expense immediately on the 2015 tax return. Companies requiring more than $200,000 in capital equipment investment in 2015 will need to manage the tax ownership of those assets in order to maintain a Section 179 write-off. By using an equipment lease for assets over $200,000, the leasing company becomes the tax owner of the equipment, which allows businesses to maintain a Section 179 deduction on assets below that threshold.
Selecting A Partner
The needs of machine shops are unique and must be considered when leasing equipment in the fourth quarter, so it is important to select a finance partner that is knowledgeable and financially strong. By selecting the right partner, shops can get ahead of the competition and experience tax benefits that only come in the fourth quarter.
Peter K. Bullen is senior vice president for Key Equipment Finance. He can be reached at firstname.lastname@example.org or at 216-689-8579